Brad Setser

Brad Setser: Follow the Money

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The scale of central bank (and sovereign fund) intervention in global markets has been breathtaking

by Brad Setser
September 18, 2008

I think we now know why the US Treasury is selling Treasury bills like mad to raise money for the Fed.

$180 billion is a lot of money to lend to other central banks so that they can supply dollar liquidity in their national markets. The ECB is now prepared to lend out more than $100 billion US dollars to European financial institutions:

Under the latest action plan drawn up by central bankers, the ECB said it would expand its armoury by offering “for as long as needed” $40bn in overnight funds to eurozone banks. The ECB is also expanding its reciprocal arrangements with the US Fed to increase to $25bn the amount it provides in the market for 28-day funds and $15bn over 84 days. Under the expanded plans, the amount of outstanding dollar liquidity provided by the ECB could reach as much as $110bn – compared with $50bn previously.

No doubt the Fed is financing a host of US banks and broker-dealers as well.

The Fed’s balance sheet indicates that it provided an additional $100b in direct credit to the US financial system over the last week (look at the Wednesday to Wednesday change in “other loans” rather than the change in the weekly averages) — “Primary credit” rose by $10b, roughly $60b was drawn from the prime dealers credit facility and another $28b was provided in “other credit.” Then throw in another $10b increase in the securities the Fed has lent to dealers, bringing that total to $127b. By my count — which could be off — the Fed has now provided around $500b in credit to the US financial sector over the last 12m months.*

And given how much has happened, that will probably be a couple hundred billion or so out of date. Or something like that.

Financial institutions have loss confidence in each other. American savers may soon lose confidence in money market funds — a key source of financing for a host of financial institutions. That effectively leaves the Fed — and other national central banks — as the only institution willing to supply financing to many financial institutions. Just think how extraordinary it is for the chief economist of Goldman Sachs to say that there has been a complete loss of confidence in the markets.

““There’s a complete lack of faith in the markets,” said Jim O’Neill, chief economist at Goldman Sachs Group Inc. in London. “There’s a lot of cash hoarding and people losing trust in banks, so the central banks are acting to relieve that. This might not be the last time they have to act.”

The FT puts it simply in their leader.

“They have now duly become the last resort in a generalised panic in the core of the world’s financial system on a scale not seen at least since the 1930s. Nobody trusts any credit, other than that of governments themselves. In this situation, the rule is simple, clear and well-known ever since the days of Walter Bagehot. Central banks must lend freely against collateral of even borderline value. If the private sector will only lend to the government, the government must finance the private sector. It is as simple as that.”

It isn’t just the G-7 banks either. Emerging market governments have been intervening heavily as well, led by Russia. $60b is a lot of money for Russia’s three big state banks. Supplying the state banks with cash allows them to lend to other banks – thus helping to address the broader squeeze — though it hasn’t worked so far:

The finance ministry pledged to pump a further $60bn into short-term deposits in the three main state-controlled banks, however, earlier injections had failed to be transferred into the broader system as interbank lending froze.

Russia’s government is clearly going to take other steps to support its stock market as well. Its ample reserves give it a lot of options even if it is getting really squeezed by a combination of trouble in global markets (lots of Russian banks need to rollover external credit lines), falling oil prices and a self-induced rise in Russian political risk.

And a host of sovereign funds have been supporting their local equity markets. The CIC is buying shares in the big three Chinese state banks (it already owns a majority of these firms stock, so it is adding to its already large position).

There is certainly talk that the big Gulf funds should do more to support their local markets. No doubt there are other examples as well.

Such support clearly reflects a policy choice about how best to use the state’s wealth — market stabilization is a government function. It isn’t necessarily the action of an investor motived solely by commercial considerations.

The world continues to change at an incredible pace. Just think that a few years ago, China was expected to need to privatize its big state banks in order to develop its own financial system. And today there is a possibility that the CIC will intervene not just to support China’s state banks but also to support Morgan Stanley. Rather than resulting in the privatization of China’s state banks, the current form of financial globalization could lead China’s state to take control of a paragon of American financial capitalism.

* Repos increased by around $95b, the term facility provided $150b, other credit adds in $120b (with a big increase this week), “Maiden Lane” (i.e. Bear assets) accounts for about $30b and roughly $125b of securities have been lent to dealers. If my accounting is off, please let me know. I have left out a $60b increase in the Fed’s “other assets.”

** Incidentally, the Fed’s custodial holdings of Treasures and Agencies rose by $18.5b over the last week; the quiet bailout continued. Holdings of both Treasuries and Agencies increased — with Treasury holdings rising by more.

38 Comments

  • Posted by Dave C.

    The Federal Reserve knuckleheads just can’t comprehend:

    It’s not a liquidity problem, it’s a solvency problem with trillions of dollars of level-3 toxic waste hidden in SIVs. Injecting more liquidity for loans to deadbeat investment banks merely postpones the day of reckoning. Another wave of Fed liquidity doesn’t solve the problem. The toxic waste must be written off the balance sheet books for the system to recover.

  • Posted by Scaramanga

    CNBC Steve Leisman a few minutes ago. He said last night’s massive liquidity injection from the Fed has not shown up in the credit markets and has “pretty much disappeared”, he said the “massive amount of money has to show up somewhere but where did it go? We don’t know …” and it is the “elephant in the room but an elephant that no one can find” or words to that effect.

    Hopefully it didn’t go straight into Swiss Bank accounts.

  • Posted by moldbug
  • Posted by Robinia

    I echo Barney Frank’s comment that nobody in a democracy should have the power to dispense as much money as the Fed has been dispensing based on one person’s authority, no matter how good that individual judges his advisors to be.

  • Posted by JKH


    I don’t know, but it’s not clear to me why ECB injections of US $ 100 billion US in Europe, originally sourced from the Fed, wouldn’t ultimately flow back to the US in the form of increased dollar liability balances with US clearers here and their increased reserve balances with the Fed, potentially requiring additional offset operations by the Fed here. I must be missing something. Perhaps Brad, or RebelEconomist or anybody has an opinion on this or can even explain it.

    (Sbfb)

  • Posted by Blissex

    «The Federal Reserve knuckleheads just can’t comprehend: It’s not a liquidity problem, it’s a solvency problem»

    They know very very well. They have known for a (fairly long) while. The problem is that they cannot say it or act on it; they are all Republicans and there is an election that a Republican candidate *must* win, and admitting anything like that is a loser.

    «with trillions of dollars of level-3 toxic waste hidden in SIVs.»

    Well, the solution to that for now is for the Fed and the Treasury to hide a lot of that toxic waste inside various SIVs created and owned by the Fed (the various facilities and GSEs and semi-nationalized companies), and keep them alive for while.

    «Injecting more liquidity for loans to deadbeat investment banks merely postpones the day of reckoning.»

    As long as it is postponed to after the November election…

    «Another wave of Fed liquidity doesn’t solve the problem.»

    Given that there is a good chance that Obama wins that election, why should a Republic team solve the problem for him? Better wait until it is known who has won, and if he wins, let the problem explode in his face.

    «The toxic waste must be written off the balance sheet books for the system to recover.»

    Sure, but if you write all that off, what happens to the capital of all major private financial companies? Either the USA provides for free new capital to them (if McCain wins) or they are left to twist in the wind (if Obama wins, and then it’s all his fault no matter what he does).

  • Posted by Blissex

    «nobody in a democracy should have the power to dispense as much money as the Fed has been dispensing based on one person’s authority»

    It is not one person’s authority — Hank Paulson is part of a very disciplined team of Republican representatives in the administration, which usually works closely with the RNC and the McCain campaign to stay on message and on strategy.

  • Posted by Scaramanga

    ” I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around they will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.”

    Thomas Jefferson,

    Letter to the Secretary of the Treasury Albert Gallatin (1802)

    3rd president of US (1743 – 1826)

  • Posted by Dave C.

    Paulson Seeks Resolution Trust Corporation “Solution”

    http://globaleconomicanalysis.blogspot.com/

    When you have done as much damage to taxpayers and the economy as Paulson has, one just might expect for him to go into hiding until the next administration fires him.

    However, that would be wishful thinking as Paulson Seeks Resolution Trust Corporation “Solution”.

    CNBC’s Gasparino reports his Wall Street sources say that Treasury Secretary Paulson is talking about a Resolution Trust Corporation-type solution to the current crisis. The RTC was created during the savings and loan crisis of the 80s.

    Take the estimated cost of the former RTC and multiply it by a factor of ten. I reserve the right to change that call when more specifics are announced. Adding trillions of dollars in subprime debt to the US government balance sheet will only further destroy the monetary value of the US Dollar.

  • Posted by manch

    Brad, anxiously waiting for your analysis of the Fed’s balance sheet.

    With China, Russia and maybe even the Gulf using their reserves to prop up local markets, will it slow the flow of their USD purchase? What will it mean to the capital inflow US is increasingly relying on?

    And now RTC? Help! I don’t know how to process all these…

  • Posted by Blissex

    «Paulson Seeks Resolution Trust Corporation “Solution”»

    As to the RTC and the story of the S&L scam, here is from an anonymous donor a link to a very good discussion of it, from the time when people where trying to figure out a solution:

    http://www.sec.gov/news/speech/1989/062689grundfest.pdf

    Amazing deja vu sense…

  • Posted by Dave C.

    What is the difference between a Chinese bank and an American Investment Bank?

    (A) The Chinese bank has money in it. The US bank is bankrupt.

    (B) There is no difference. They are both supported by the Chinese state.

  • Posted by TM

    “Well, the solution to that for now is for the Fed and the Treasury to hide a lot of that toxic waste inside various SIVs created and owned by the Fed (the various facilities and GSEs and semi-nationalized companies), and keep them alive for while.”

    I think you hit it on the nail. The Fed is in essence creating a SIV like RTC to remove the bad assets from the banking system with treasury swaps. The treasury is recapitalizing the Fed through the back door via “loans”.

    The Feds know that in this election year there is no political will in congress to approve of a such a trust fund to save the hide of the banks.

  • Posted by Dave C.

    So much for the “no more bailout policy”.

    It sounds like Paulson plans the “mother of all bankster bailouts” with an US Treasury sponsored RTC.

    How much debt can the US government accumulate before the world’s creditors say “no more”?

    Perhaps we’re not there yet, but getting closer every day.

  • Posted by Rien Huizer

    JKH,

    Good question, difficult to answer. Probably, some of it, Does it matter? The key is that banks lend less to one another and that institutions are concentrating their liquid funds. The firms that need capital will not get it (and cannot afford the cost anyway, with expensive liabilities, illiquid assets and large sunk costs) .Society cannot afford a meltdown, hence the solution of large scale nationalization seems pretty competitive viz other options. Of course, if the US nationalizes these firms, foreign authorities might treat them as belonging to a single BHC, as the US would do in a similar situations. Right?

  • Posted by Scaramanga

    “Schumer advocated a Great Depression-era Reconstruction Finance Corp. model, different from the Resolution Trust Corp.- type plan others have floated. Another RTC, which was a 1990s agency that sold devalued assets in the Savings and Loan Crisis, would “simply transfer excessive risk to the U.S. government without addressing the plight of homeowners,” he said.”

    Here comes the important part:

    “Schumer urged forming an agency to inject funds into financial companies IN EXCHANGE FOR EQUITY STAKES AND PLEDGE TO REWRITE mortgages and make them more affordable.”

    It´s even more insane then we think! The Government is going to become a major shareholder in exchange for a loan and that loan will only be granted if the loans to home owners is renegociated.

    http://www.bloomberg.com/apps/news?pid=20601087&sid=afIu492CyWMw&refer=home

    SHORT THE LIVING HELL OUT OF FINANCIALS ….

    This is going to slaughter the shareholder and possibly the bond holder. Their going to instutionalize the “AIG-Model”!

  • Posted by Twofish

    Scar: Fed has not shown up in the credit markets and has “pretty much disappeared”, he said the “massive amount of money has to show up somewhere but where did it go? We don’t know ….”

    They went into short term Treasury bills. Yields on 3M Treasuries are basically zero. There is an interesting fight going on right now in which the flight to safety is pushing massive amounts of money into US Treasuries and government bonds, while the Central banks are taking these Treasuries and pushing the money out as quickly as they can.

    Also I think that the article somewhat overstates the power of sovereign wealth funds. They might be able to prop up a small stock market such as Shanghai or Moscow, but the global storm is much too big for everyone except the central banks.

    There are three movie scenes that pop into my mind:

    1) is the scene from Mary Poppins where there is this massive bank run. What we are seeing right now is the biggest bank run the world has ever seen.

    2) the second is the end of “It’s a Wonderful Life” where people show up with lots of cash.

    3) is the “Ride of the Valkyries” scene from Apocyclopse Now. Helicopters from all of the nations of the world converging on a village and dropping cash.

  • Posted by JKH


    Rien Huizer,

    Purely a technical question, for Fed balance sheet wonks.

    Agree with your other points, directionally.

  • Posted by Twofish

    Probably the last time I make the point about conspiracy theorists looking at the wrong conspiracy. There are a small number of people that run the world, but they aren’t all Republican. The people that run the world have their tentacles into both parties.

    The Wall Street branch of the Bavarian Illuminati is actually more Democratic than Republican.

    http://ap.google.com/article/ALeqM5gL_52COXbMNp66–saYnfORmwtGwD938M0J80

    Most of the people I know in investment banking are planning on voting for Obama.

    Part of the reason is that most people in investment banks aren’t super rich and health insurance and job training looks really good now if you are upper middle class and out of a job.

    One reason for this is that banking is an international affair, and most people from Europe find Bush and the Republican Party to be loony.

  • Posted by Cedric Regula

    Mama Mia. Hank The Goombah is gonna upsize RTC !!!

    Dey say dey need a “bad bank”? Whadadeycall what dey been doing so far…playing wid demselves?

    Why does this always happen on tennis night? I gets home and find out the feds got me on the hook for another half a trillion. And all of yous too, of course. Whadadeythink…I steal for a live’n or something?

  • Posted by gillies

    you shouldn’t shout ‘fire’ in a crowded theatre. you shouldn’t shout ‘fire engine’, either . . .

  • Posted by Blissex

    «There are a small number of people that run the world, but they aren’t all Republican. The people that run the world have their tentacles into both parties.»

    Well, yes the Democrats had Rubin instead of Paulson, and lots of Wall Street fund the democrats too. The GSEs were on the Democrat side mostly, but most banks are solidly Republican.

    However what matters now is that the current administration is Republican and they know very well who their sponsors are.

    There is a very good chance that a Democrat administration would also be in the pocket of Wall Street, and a lot of the current troubles go back to Clinton’s administration (include executive power grabs and renditions and 4th amendment trick). But there is a large amount of difference in style and amount of the corruption, and in restraint.

  • Posted by Blissex

    «Most of the people I know in investment banking are planning on voting for Obama.»

    Much good it will do to them. What matters is campaign donations, and they made them to Hillary, a good triangulator like her husband.

    «Part of the reason is that most people in investment banks aren’t super rich and health insurance and job training looks really good now if you are upper middle class and out of a job.»

    You mean: losers. It is un-american to care about losers, hey in America even many losers don’t care about losers and vote for the Republicans regardless.

    :-)

  • Posted by RealThink

    From the CNBC page on RTC redux

    “Such a move, according to its advocates, would allow banks to shovel bad debt off their balance sheets and allow the firms to go back to business as usual. It would also eliminate the need for individual company bailouts.

    In turn, that could allow the housing market to recover because it would restore banks willingness to lend.

    “This will bring real trust back into the market.” Donald Marron, chairman of Lightyear Capital, said on CNBC. “It would free up real, spendable capital in these organizations. They can use that to make loans, to make transactions and to build confidence in the system. This is a confidence crisis.”

    For people aware of the physical limits to growth, aka Peak Oilers, this is as scary as it gets, because it’s almost a certainty that those fresh funds will not be allocated to uses that will make society better able to cope with oncoming Peak Oil and related peaks, but rather more vulnerable.

    Seriously, I expect all this was just a shenanigan for tomorrow’s options expiration. Because if it’s not, the US is in deep, deep trouble.

  • Posted by RealThink

    Seriously, Brad, I do recommend you take the trouble to consult with Matthew Simmons, CFR member and leading investment banker for the energy industry, for his views on recent financial affairs from a Hubbert’s Peak-aware perspective.

  • Posted by FG

    It looks like the government will have to borrow a massive amount to bail-out the banking system.

    The debt moved up from households to banks, from banks to government, with the assumption that the US government can borrow unlimited amounts of money.

    So in the end, it all comes down to this: At what point do foreign central banks stop bailing out the US government? Which is why we are here.

  • Posted by Cedric Regula

    Realthink:

    Confidence crisis my sweet pe’toot. What a goombah. All my com padres are talking about running out and buying a Peak House. NOT ! (a little humor there…HAHAHHAHA).

    Uncle Enzo is closing the fill’in station and a saving the gas for next year when he figures he’ll get $10/gallon for it.

    Sure the CICs’ll go for it too. Maybe the Arabs will buy out the rest of Shiti for a piece of the action.

    Them treasureals is selling like coke on Wall Street, so there’s sure to be more rebate checks on the way. Government gotta feed the babies, or mom marches with a frying pan and clobbers the first politician she sees.

    Gonna be a good year!

  • Posted by bsetser

    FG — custodial holdings increased by $18b last week; central banks have kept on buying. tho to be honest, right now i suspect almost all purchases are coming from a single account …. tho the saudis may be chipping in ways that aren’t captured in the custodial data as well.

  • Posted by algernon

    Scaramanga,
    I think Jefferson viewed money as gold/silver & was expressing a view of fractional reserve banking as the source of inflation & credit bubbles, perhaps anticipating Murray Rothbard.

  • Posted by ZFC

    “SHORT THE LIVING HELL OUT OF FINANCIALS”

    GS and MS have the same plan too. Just don’t short their shares. Who needs CIC to recapitalize when you have other financials and the US taxpayer ?

    From Mish’s blog today:

    “Morgan Stanley and Goldman began erasing their declines after the California Public Employees’ Retirement System and the New York State Common Retirement Fund joined the California State Teachers Retirement System in deciding to stop lending its shares of the two companies”

  • Posted by Twofish

    Blissex: Well, yes the Democrats had Rubin instead of Paulson, and lots of Wall Street fund the democrats too. The GSEs were on the Democrat side mostly, but most banks are solidly Republican.

    Depends on the type of bank. Very broadly speaking, most people in investment banks tend toward being Democrat, while most people in hedge funds tend toward being Republican. Wall Street *isn’t* a core supporter of the Republican party, and the core Republicans come from states without large finance industries. That’s why McCain is bashing Wall Street, he knows he is going to lose NY.

    Personally, speaking I’m partial toward Obama, because he seems to have a better handle on what solutions are actually needed. I don’t think that the deregulation/anti-government stance by McCain is really going to fix the problem. I don’t think the problem is fixable via an American-only approach, and not offering any useful solutions and then going ahead and bashing Wall Street, just makes things worse.

    Blissex: You mean: losers. It is un-american to care about losers, hey in America even many losers don’t care about losers and vote for the Republicans regardless.

    That’s probably why people in the sausage factory (i.e. Wall Street investment banks) tend Democrat. If you are a very, very, very good trader, then on average you will lose in 40% of the trades that you make. The trick is to not throw bad money after good, and not to lose so much that you are out of the game. If you are winning 95% of the time, then there is something very wrong. You probably are in a bubble.

  • Posted by Twofish

    Jefferson had many positive virtues, but in anything having to do with finance and business he was a total idiot. Alexander Hamilton is the person that really understood business and finance.

  • Posted by Judy Yeo

    The short squeeze began yesterday, and if the powers that be have any sense, they;ll continue today. Pardon the paranoia but wouldn’t be surprised if the ones selling short come from no less venerable institutions as GS or citi ; cannabalism seems to be the order of the day…

    there have even been official pronouncements that short sellers will be hunted down, at least by the brits, wonder if man is quaking…

  • Posted by algernon

    Twofish.
    Hamilton & Jefferson were both genius’ I’ll grant. But when you reflect that all modern booms & busts are generated by credit bubbles & there collapse, and further that this flows from leverage of the sort to which Jefferson is probably alluding, you might aver with more diffidence.

  • Posted by RebelEconomist

    jkh,

    In an effort to live up to your expectations of me as a central bank balance sheet wonk, I have thought about the effect of the Fed’s reciprocal arrangements with the other central banks. I consider that you are right; the dollars lent to those central banks (against collateral of their own currency) may come back to the US moneymarket. In fact, I guess they never really leave, since they will be credited to each central bank’s account at the NY Fed.

    It seems to me that the extra dollar balances credited to the foreign central banks’ Fed accounts under the reciprocal arrangement are like an additional source of potential dollar liquidity, granted to the foreign central banks to use at their discretion to help their own banks. Presumably, if used, they fit into Fed operations like a customer repo; the NY Fed Trading Desk allows for them when deciding what their own operations should be.

    The foreign central banks could have achieved the same result by repoing some of their reserves securities with the Fed and holding the proceeds in their Fed accounts. Indeed, one wonders why the Fed did not expect the central banks involved to this instead; perhaps not all the central banks concerned have enough treasuries in custody with the Fed.

    In practice I would not expect that the foreign central banks’ dollar lending needs to be offset by the NY Fed Trading Desk. I would imagine that that dollar assistance by the foreign central banks coincides with tight dollar money market conditions anyway, when the NY Fed trading desk are not unhappy for their colleagues to be lending as well.

  • Posted by JKH

    RebelEconomist,

    Thanks for your response. You met my expectations (which I expected :)). I agree with your explanation.

    In thinking it through quickly the other day, I skipped the first step you pointed out – dollars deposited in foreign CB accounts with the Fed. I saw the final step only, with the distribution of dollars to foreign commercial banks, and the dollar balances of those banks clearing through to their dollar accounts with their own New York clearers.

    So these dollars should show up in the excess reserve setting of the Fed, other things equal. The Fed desk would act accordingly. These reserves in their final form would be indistinguishable from those supplied directly through domestic operations.

  • Posted by Flabbergasted in Palo Alto

    Brad, you say “…going from an economy with too much credit to one with far too little.” You may be right and I certainly esteem your opinion highly. But this is a risk, in the future, and I am not sure how well the future can be predicted. I am also not sure what “too little” credit really means. Talking about risks, how about the risk of digging deeper into a debt hole, so deep that at some point there is no bearable escape for the economy or the nation’s middle class?

    Before we press all the panic buttons, let us set some criteria for a “deflationary” or “credit” crisis. Here are some ideas: 1. House prices return to 2000 levels in real (inflation adjusted) terms. 2. Oil prices return to their levels of two years ago (about $60/barrel). 3. You cannot get a loan to buy a house, when you have a twenty percent down payment and the income to support the payments (house payments about 1/3 of gross income). 4. If you do not like my criteria, please set you own criteria, but nothing like TED spreads.

    Otherwise, this looks like another scare to keep the gravy train going for very few but very influential people at the expense of the gullible hoi polloi. On a lighter side, but very relevant, do not miss Jon Stewart’s Daily Show of September 25.

  • Posted by B

    To all those posting comments in relation to coutries at war, the financial crisis etc on this site…wake up, the people behind this site are part of the Illuminati!

    Seriously, you people deserve whats coming to you when the one world governemnt eventually forms!

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